KEDIA SHARES & STOCKS BROKERS LTD,MUMBAI vs. JT CIT (OSD) 4(3), MUMBAI

IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI BENCHES “A” MUMBAI

BEFORE SHRI MAHAVIR SINGH (JUDICIAL MEMBER) AND SHRI N.K. PRADHAN (ACCOUNTANT MEMBER)

ITA No. 4033/MUM/2013 Assessment Year: 2009-10

M/s. Kedia Shares & Stocks Brokers Ltd. Vs. JCIT (OSD) 4(3) 418/508 Commerce House, 140 Aayakar Bhavan Nagaindas Master Rd. Mumbai – 400020 Mumbai - 400023 PAN No. AAACK2528E

(Appellant) (Respondent)

Assessee by : Shri Ajay Singh, AR Revenue by: Shri B.S. Bist, DR

Date of Hearing : 12/01/2017 Date of pronouncement: 07/04/2017

ORDER PER N.K. PRADHAN, AM This is an appeal filed by the assessee. The relevant assessment year is 2009-10. The appeal is directed against the order of the Commissioner (Appeals) – 8, Mumbai and arises out of order u/s 143(3) of the Income Tax Act, 1961 (the ‘Act’).

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1.1. He ought to have appreciated that the assessee is entitled to set of losses arising from delivery based share purchase / sale activity in ‘cash segment’ against corresponding profits arising from reverse position simultaneously taken in ‘derivative segment’ (having identical underlying shares) (i) in view of exception carved out in S. 43(5)(b) of the Income Tax Act read with Explanation 2 to Section 28 of the Act, assessee being a dealer in shares. (ii) in view of exception carved out in Section 43(5)(c) of the Income Tax Act read with Explanation 2 to Section 28 of the Act, assessee also being a member of the Stock Exchange. 1.2 The learned CIT(A) erred in sustaining the action of the AO in treating the loss arising in ‘cash segment’ as ‘speculative loss’ by invoking Explanation to Section 73 on the face of established facts that such transactions in cash segment is integral part of composite arbitrage / hedging mechanism and not merely purchase / sale of shares simplicitor on stand alone basis. 1.3 He ought to have appreciated that Explanation to Section 73 has no application in the facts of the case in view of specific exceptions provided to certain class of transactions namely hedging, jobbing, arbitrage, derivative transactions in proviso to Section 43(5) read with Explanation 2 to Section 28 of the Act. 1.4 He ought to have further appreciated the distinguishing features of cash segment transactions which are not stand alone transactions of purchase and sale of shares in the courses of regular dealings to be covered within the ambit of Explanation to Section 73 but are adjunct of simultaneous opposite transactions in derivative segment and thus inseparable in the bundle of arbitrage transactions falling in the specific exception clause to Section 43(5). 1.5 The learned CIT(A) erred in not applying exceptions provided in 43(5)(b) / 43(5)(c) to one leg of transaction namely cash segment while applying exception 43(5)(d) to other leg of transaction in derivative segment which is ex-facie “arbitrary”, unjust and contrary to law and judicial pronouncements. 1.6 The learned CIT(A) erred in law in not making ‘harmonious construction’ between provisos to Section 43(5) and Explanation to Section 73 for computing speculation income under Explanation 2 to Section 28. He ought to have appreciated that notwithstanding that the Explanation to Section 73 do not distinguish between delivery and non-delivery share transactions, the benefit of exceptions carved out

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in Section 43(5) applicable to even otherwise singularly speculative non-delivery transactions do apply to delivery based share transactions too. 1.7 Notwithstanding and without prejudice to above, the learned CIT(A) ought to have appreciated that both; delivery based share transactions in cash segment as well as derivative transactions are excluded from the definition of speculative transaction under Section 43(5) of the Act and therefore ‘aggregation’ of purported share trading loss and profit from derivative transactions should be done before deeming fiction in Explanation to Section 73 of the Act comes into play. 2. The learned AO erred in law in not adjusting remaining non speculative derivative income Rs. 8,76,699/- [Rs. 245.79 lacs less Rs. 237.02 lacs (non arbitrage derivative portion)] against loss arising in delivery based share transactions (non arbitrage portion in cash segment); both being non speculative u/s 43(5) before resorting to Explanation to Section 73 of the Act [on remaining loss arising in delivery based share transactions in cash segment]. 3. The learned AO further erred in law in not adjusting impugned arbitrage income Rs. 26,79,401/- (non speculative) against loss arising in delivery based share transactions (non arbitrage portion in cash segment); both being non speculative u/s 43(5) before resorting to Explanation to Section 73 of the Act [on remaining loss arising in delivery based share transactions in cash segment]. 4. The learned CIT(A) erred in not giving any findings on the grievance of the assessee that while determining assessed income, the learned A.O. has taken returned business loss at Rs. 1,21,60,460/- purportedly out of inadvertent error instead of correct figure of Rs. 1,32,24,729/- without assigning any reason thereof. 5. The appellant submits that the above grounds and sub grounds of appeal are alternative, independent and without prejudice to one another. 3. Briefly stated, the facts are that the assessee i.e. M/s. Kedia Shares & Stocks Brokers Ltd. (KSSBL) filed its return of income for the A.Y. 2009-10 on 29.09.2009 declaring total loss of Rs. 13,224,729/-. The activities of the assessee-company consists of (i) trading in shares and derivatives (arbitrage and trading), (ii) brokerage and (iii) depository services. The Assessing Officer (AO)

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noticed that KSSBL has shown loss on security trading activities of Rs. 42,993,437/-. This loss has been set off against the business income which has resulted in business loss of Rs. 13,224,729/-. The AO came to a finding that KSSBL is hit by Explanation to Section 73 of the Act. He asked the assessee to explain why the Explanation to Section 73 should not be invoked and why the loss in share trading should not be treated as speculation loss. In response to it, KSSBL filed a revised computation of income on 15.11.2011 showing total income of Rs. 56,19,057/-. The A.O. has produced the explanation filed by the assessee at page 2 – 9 of the assessment order. The AO rejected the explanation of the assessee on the reasons that (i) the derivative transaction cannot be covered under Explanation to Section 73 as there is a specific provision in section 43(5) which has categorised the derivative transaction as non-speculative, (ii) the loss on profit in derivative transaction carried out in recognised stock exchanges has to be treated as non-speculative in nature, (iii) by virtue of Explanation to Section 73, the loss in trading of shares by a company which is otherwise a non-speculative transaction is deemed to be speculative in nature, thus the transaction in F&O becomes non- speculative transaction by virtue of section 43(5) and transaction in trading of shares (barring the exceptions specified) becomes a speculative transactions, (iv) any loss or profit in share trading is realised only on the sale of the share in the cash market. Similarly, the loss or profit in the F&O market is realised only when the F&O are settled,(v) section 43(5) deals with those transactions which are settled otherwise than actual delivery. Transaction of arbitrage between the cash market and F&O market cannot be covered u/s 43(5), (vi) Even when the scrips are sold in the F&O market on so- called hedging against the shares acquired in cash market, the profit

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or loss on such sale would be booked as non-speculative profit / loss. In the cash market, when the same underlying scrips are sold at a later date at a loss, the said loss by virtue of Explanation to Section 73 would be treated as speculative loss, (vii) even if the assessee had been able to prove that it indulged in arbitrage, the assessee being a company, the provisions of section 73 would override the provisions of section 43(5) of the Act.

After adding Rs. 3,04,865/- allocated as proportionate expenses on share trading, the AO disallowed the share trading loss of Rs. 4,32,98,302/-. The AO started with business loss of Rs. 1,21,60,460/- and arrived at business income of Rs.3,11,37,840/-

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118 TTJ 465, (iii) since the assessee’s entire income is from share trading, the loss or profit earned through these transactions is deemed to be speculative transactions as per Explanation to Section 73 of the Act.

In view of the above, the learned CIT(A) held that the assessee is not entitled to set off the losses in share trading with the profits earned through F&O transactions in derivatives as these are non speculative in nature. Thus the learned CIT(A) dismissed the appeal filed by the assessee.

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of shares of itself. The assessee is also dealing in derivatives. Dealing in derivatives has been excluded from the ambit of speculative transactions w.e.f. A.Y. 2006-07. The issue before the Hon'ble High Court was with regard to the A.Y. 2005-06. The question arose whether the assessee was entitled to set off the loss arising out of purchase and sale of shares. The Hon'ble High Court held that “the assessee, in the present case, principally is a share broker, as already indicated. The assessee is also in the business of buying and selling of shares for self where actual delivery is taken and given and also in buying and selling of shares where actual delivery was not intended to be taken or given. Therefore, the entire transaction carried out by the assessee, indicated above, was within the umbrella of speculative transaction. There was, as such, no bar in setting off the loss arising out of derivatives from the income arising out of buying and selling of shares”.

In Baljit Securities (P) Ltd. (supra) the Tribunal has followed the above judgement of the High Court.

In M/s. J.M. Financial Services Ltd. (supra), the assessee had carried out cash future arbitrage and earned a profit from the said activity. It submitted before the AO that the activity of buying and selling of shares in cash segment and future segment was a composite activity carried out by the assessee. However, the AO was not convinced with the submission of the assessee and held that future and option transactions were non-speculative as per section 43(5) of the Act, whereas loss on purchase and sale of shares was to be considered as speculation loss as per Explanation to Section 73 of the Act. The Tribunal held that (i) in the case of CIT vs. DLF Commercial Developers Ltd. (2013) 35 taxmann.com 280 (Delhi), the Hon'ble

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Delhi High Court has held that in terms of Explanation to Section 73, by all accounts, derivatives are based on stocks and shares which fall squarely within Explanation to Section 73 and, therefore, loss from sale – purchase of such derivatives would be speculative loss. Hence both the transactions i.e. the transactions in the derivative and cash segment can be treated as speculative transactions as per Explanation to Section 73 and therefore the profit or loss against both the segments can be adjusted or set off against each other.

7.1 Now we deal with ground no 4 of the appeal. We find that the assessee has shown total loss of Rs. 1,32,24,728/- in the return of income filed for the impugned assessment year. The AO has mentioned it at page 1 of the assessment order. However the AO has taken the business loss at Rs. 1,21,60,460/- in his computation of income at page 12 of the assessment order. As this is mistake apparent from record, the AO is directed to verify the same and rectify it.

7.2 We now turn to the other grounds of appeal and take them together as the address a common issue. We begin with the legal underpinnings of the issue for consideration. Section 73 of the Act provides that any loss, computed in respect of a speculation business carried on by the assessee, cannot be set off except against profits of another speculation business. Explanation 2 to section 28 provides that where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business is deemed to be distinct and separate from any other business, and is referred to as ‘speculation business’ for the purposes of the act.

Section 43(5) defines the term ‘speculative transaction’, as a transaction in which a contract for the purchase or sale of any

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commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. Proviso to section 43(5) lists certain exceptions to the ‘speculative transactions’, vide clauses (a) to (e). Clause (d) of the proviso provides that an ‘eligible transaction’ in respect of trading in derivatives referred to in section 2(ac) of the Securities Contracts (Regulation) Act, 1956 carried out on a recognised stock exchange shall be deemed not to be a speculative transaction.

Therefore, derivatives transactions satisfying the needs of being treated as ‘eligible transactions’ are not regarded as speculative transactions for the purposes of computing business profits u/s 28.

The Explanation to section 73 provides for a deeming fiction where under certain business carried on by a company is deemed to be a speculation business. This fiction of explanation to section 73 applies only to a company. If any part of the business of the company consists in the purchase and sale of shares of other companies, such company is deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares. Certain exceptions to this fiction are provided in this regard.

7.3 “Derivative” is an instrument whose value depends upon its underlying cash or physical asset. Hence it means that the value is derived from the value of the underlying assets like foreign exchange, currency, securities and commodities. Derivatives include forward, future and option contracts that are of a pre-determined fixed duration, linked for the purpose of contract fulfilment, to the specified value of real or financial asset or to index of securities.

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7.4 As per the profit & loss account of KSSBL for the year ended 31.03.2009, the income comprises of the following:

Brokerage Income Rs. 10,922,419.89 Profit on Security Trading Rs. (42,993,437.98) Activities Profit on Derivative Trading Rs. 24,579,590.40 Profit on Mutual Fund Rs. 431,575.51 Capital Gain Dividend Received Rs. 2,552,678.37 Interest Received Rs. 3,032,715.45 Depository Service Charges Rs. 1,454,618.65 Other Income Rs. 696,703.81

7.5 The Hon'ble Calcutta High Court in the case of CIT vs. Eureka Stock & Share Broking Services Ltd. (2016) 74 taxmann.com 114 (Cal) has held that where assessee incurred loss on account of sale and purchase of shares, which had no connection with its business as a share broker, said loss would be treated as a speculation loss which could not be set off against brokerage income earned as share broker.

In Priyasha Meven Finance Ltd. vs. ITO (2008) 24 SOT 422 (Mum), the assessee was a share broker having brokerage income and was also trading in shares in its own name. For the A.Y. 2002-03, it filed its return of income showing share trading loss suffered from sale and purchase of shares and claimed same to be set off against its brokerage income. The AO held that in so far as trading in shares was concerned, it was a speculative business and treated loss suffered from this activity as a speculative loss and accordingly, did not allow set off of loss in question from regular business income of the assessee. The Commissioner (Appeals) following the judgement of the Hon'ble Calcutta High Court in CIT vs. Arvind Investment Ltd. (1991) 192 ITR 365 upheld the order of the A.O. On appeal, the Tribunal upheld the order of the learned CIT(A).

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In C.D. Equisearch (P) Ltd. vs. DCIT (2015) 152 ITD 652(Kol.), it has been held that “ Where assessee, a stock broker having transactions in different segments on its own account as well as clients’ account, claimed set off of loss in share trading business against other business income, in absence of any material on record showing that assessee was doing an integrated business giving rise to different classes of income, its claim for set off being in contravention to section 73, was to be rejected.”

7.6 Having discussed the above, we are only concerned here about the adjustment between loss on security trading activity and profit on derivative trading by KSSBL. We turn to the submission filed on 15.11.2011 along with revised computation of income by KSSBL before the AO. The same is produced below:

The company has also earned income from dividend and interest.

Amount (Rs) Loss on Security Trading Activity 4,29,93,438/- Profit on Derivative Trading 2,45,79,590/-

A statement of break-up of security trading activity including arbitrage is enclosed herewith.

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I The loss on share trading (total amount Rs. 4,29,93,438/-) is bifurcated as under: Loss on Arbitrage Rs. 2,10,23,490/- Loss on Trading Rs. 2,19,69,948/- 4,29,93,438/-

The profit on derivatives (total amount Rs. 2,45,79,590/-) is bifurcated as under:

Loss on Arbitrage Rs. 2,37,02,891/- Loss on Trading Rs. 8,76,699/- 2,45,79,590/-

II Thus the arbitrage has resulted in profit of Rs. 26,79,401/- as per the working given hereunder: Derivative Profit on Arbitrage Rs. 2,37,02,891/- Less: loss (cash market) on arbitrage Rs. 2,10,23,490/- Profit on Arbitrage Rs. 26,79,401/-

Less: Proportionate Expenses (As per separate working sheet) Rs. 2,76,541/-

Net profit on arbitrage Rs. 24,02,860/-

III The loss on share trading has been computed as under: Loss on trading (cash market) Rs. 2,19,69,948/- Profit on derivative Rs. 87,669/-

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Less on trading Rs. 2,10,93,240/- Proportionate Expenses (As per separate working sheet) Rs. 1,66,594/-

Net loss on trading in shares Rs. 2,12,59,843/-

IV The profit on arbitrage amount to Rs. 24,02,860/- has been adjusted against loss on share trading and the remaining amount of loss on share trading has been disallowed under explanation to section 73 in the revised statement of total income. The calculation is as under: Loss on trading in shares Rs. 2,12,59,843/- Profit on arbitrage Rs. 24,02,860/- Loss on trading in share consider As disallowable under Explanation to Section 73 Rs. 1,88,56,983/-

We request Your Honour to take above on record and accept the additional income now offered as per revised computation of income.”

7.7 It is the contention of KSSBL that (i) the assessee is entitled to set off losses arising from delivery based share purchase / sale activity in ‘cash segment’ against corresponding profits arising from reverse position simultaneously taken in ‘derivative segment’ (having identical underlying shares), (ii) such transaction in cash segment is integral part of composite arbitrage / hedging mechanism and not merely purchase / sale of shares simplicitor on stand alone basis and (iii) that cash segment transactions are adjunct of simultaneous opposite transactions in derivative segment and thus inseparable in the bundle of arbitrage transactions falling in specific exception clause to section 43(5). One may refer to 1.1, 1.2 and 1.4 respectively

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of the grounds of appeal. As mentioned here-in-above, ‘Derivative’ is an instrument whose value depends on its underlying cash or physical asset. Hence it means that the value is derived from the value of the underlying asset like securities and commodities. In view of the above, the order of learned CIT(A) is set aside and the AO is directed to verify ‘having identical underlying shares’ (1.1/ grounds of appeal), ‘integral part of composite arbitrage / hedging mechanism’ (1.2 / grounds of appeal), ‘adjunct of simultaneous opposite transactions in derivative segment’ (1.4 / grounds of appeal). The assessee is directed to file the details on the above before the AO. If after verification, the contentions of the assessee in grounds of appeal 1.1; 1.2 & 1.4 are found to be correct then the AO is directed to accept the additional income of Rs. 1,88,56,982/- offered by the assessee as per revised computation of income filed along with the application dated 15.11.2011 before him. In case the assessee fails to prove the above , then the AO is directed to arrive at business income as done in his assessment order after complying with the direction in para 7.1 here-in-above. Needless to say, the AO shall allow adequate opportunity to the assessee while giving effect to this order.

Order pronounced in the open Court on 07/04/2017

Sd/- Sd/- (MAHAVIR SINGH) (N.K. PRADHAN) JUDICIAL MEMBER ACCOUNTANT MEMBER

Mumbai: Dated: 07/04/2017 Biswajit, Sr. P.S.

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Copy of the Order forwarded to : 1. The Appellant 2. The Respondent. 3. The CIT(A)- 4. CIT 5. DR, ITAT, Mumbai 6. Guard file. BY ORDER, //True Copy// (Dy./Asstt. Registrar) ITAT, Mumbai